The door may still be open for insurance companies to rely on the merger doctrine to limit their liability for Christchurch earthquake claims.
This is one of the implications of a recent Court of Appeal judgment1 relating to an insurance dispute.
The merger doctrine…
…originates from UK marine law and is potentially relevant to Christchurch because it applies to circumstances where damage is sustained across successive events. It provides that:
“Where under the same policy, a partial loss, which has not been repaired or otherwise made good, is followed by a total loss, the assured can only recover in respect of the total loss”.2
The doctrine is reflected in the Marine Insurance Act 1908 which states that the insurer will be liable for successive losses, even though the total amount of such losses may exceed the sum insured, but that where a partial loss which has not been made good is followed by a total loss, the assured can only recover in respect of the total loss.
The dispute concerned a commercial property in Christchurch which sustained damage in four earthquakes and was eventually damaged beyond repair. Repairs had been commenced but not completed between the first and second earthquake and between the second and third.
The building owner took the insurer to court seeking payment of the aggregate value of the estimated damage caused by each of the earthquakes. The insurer argued it was liable only for the cost of the repairs which had actually been undertaken and – once the building was judged irreparable – for the maximum amount payable under the policy for any one event (being $1.98 million).
The parties agreed to seek a preliminary ruling on the question of whether, where there have been a number of “happenings” within an insurance period, the insured is entitled to be paid for the damage arising from each happening to the limit on each occasion of the sum insured.
The High Court
The High Court’s short answer was ‘no’. It found that:
- the merger doctrine was unlikely to apply outside a marine context, noting that although it was provided for in the Marine Insurance Act, it was not referred to in any other insurance legislation
- the terms of the policy favoured the property owner’s argument in that it stated that the limit of liability was available for the insured to claim in the event of a loss on as many occasions as a loss was incurred during the insured period, but
- that this insurance contract had been frustrated when the building was damaged beyond repair as “the parties would have agreed that the scope of liability for subsequent happenings during the term of the insurance would not extend to require payments of sums greater than was necessary to effect repairs that were able to be undertaken before the building became irreparable”.
The owner appealed the third finding and the insurer cross-appealed the first and second findings.
The Court of Appeal
The Court of Appeal relied entirely upon an analysis of the terms of the policy for its decision. It noted that this approach obviated the need to address the doctrines of merger or frustration but – significantly – it chose to comment on them (albeit briefly) anyway.
It disagreed with the High Court’s application of the doctrine of frustration, saying that it implied into the contract a meaning which contradicted the contract’s express terms. And it left the merger doctrine in play by declining to rule it in or out.
It focused on two clauses in the contract:
- Clause 1 provided that the insurance "will pay the amount of loss or damage or the estimated cost of restoring your Business Assets as nearly as possible to the same condition they were in immediately before the loss or damage happened…”
- Clause 2 provided that, where replacement cover had been agreed, the policy would cover the cost of restoring the building or, if beyond repair, the cost of replacing it with an equivalent building.
It agreed that Clause 1 could be construed to support the property owner’s position and reached the same general conclusion as the High Court “but by a different route”. Essentially, it determined that the claims had been made and accepted under Clause 2 rather than Clause 1 and, under Clause 2, the insurer’s liability was restricted to the cost of replacing the building and to the costs of any repairs which had actually been made.
Chapman Tripp comment
Whether the parties go another round in the High Court or negotiate a settlement remains to be seen but – even if they do not pursue litigation – we expect that the merger doctrine will eventually be tested in relation to Christchurch because there are a number of similar cases in the pipeline.
The current Seddon earthquake sequence is a reminder of the real risk of damage by multiple sequential events. It will be interesting to see whether insurance companies respond to the Ridgecrest decision by revisiting policy wordings. This will be yet another issue to think about when you are next looking at your insurance arrangements.